• Selected
• Entire List

Abstract:
Mandatory disclosure is a regulatory tool intended to allow market participants to assess operational risk. We examine the value of disclosure through the controversial SEC requirement, since overturned, which required major hedge funds to register as investment advisors and file Form ADV disclosures. Leverage and ownership structures suggest that lenders and equity investors were already aware of operational risk. However, operational risk does not mediate flow-performance relationships. Investors either lack this information or regard it as immaterial. These findings suggest that regulators should account for the endogenous production of information and the marginal benefit of disclosure to different investment clienteles.

Hedge funds, operational risk, SEC filing, Form ADV

Abstract:
Using a complete set of the SEC filing information on hedge funds (Form ADV) and the TASS data, we develop a quantitative model called the ω-Score to measure hedge fund operational risk. The ω-Score is related to conflict of interest issues, concentrated ownership, and reduced leverage in the ADV data. With a statistical methodology, we further relate the ω-Score to readily available information such as fund performance, volatility, size, age, and fee structures. Finally, we demonstrate that while operational risk is more significant than financial risk in explaining fund failure, there is a significant and positive interaction between operational risk and financial risk. This is consistent with rogue trading anecdotes that suggest that fund failure associated with excessive risk taking occurs when operational controls and oversight are weak.

mutual funds, hedge funds, investments, the Omega Score

Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.

Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.

Hedge Funds, Operational Risk, Due Diligence

Abstract:
This paper reviews the recent literature on CAPM and APT, and reaches a surprising conclusion. While APT died a silent death, CAPM's progeny is alive and well! We provide a short review of the recent literature on the conditional CAPMs, intertemporal CAPMs, and higher-order Co-Moments-based CAPMs. Some of these multifactor extensions of CAPM not only have higher explanatory power than the three-factor Fama and French (FF) model, but also are not rejected in the empirical tests, while the FF model is rejected.

APT, CAPM, Multifactor Models, Beta, Asset Pricing

Abstract:
In the fields of psychology and evolution, there is a large body of theory and evidence on how individual behavior differs from group behavior, particularly for performance and risk-taking activities. Even so, relatively little attention has been devoted to this topic for research on managed portfolios, though over 50% of mutual funds are managed by a team. This study is an empirical examination of whether funds managed by individuals perform differently than funds managed by teams. Using a sample of about three thousand equity mutual funds over a twelve-year horizon, we find that though funds managed by teams has grown by seven times the rate of funds managed by individuals, there is no significant difference in performance on a risk-adjusted basis. However, funds managed by teams are significantly less risky. In addition to differences in turnover in many fund categories, the total cost of owning a team-managed mutual fund is nearly fifty basis points lower per year than a mutual fund managed by an individual, on average.

mutual funds, team, behavorial

Abstract:
Researchers have found conflicting results concerning the risk-taking response of underperforming first half mutual fund managers to economic incentives. We show analytically, numerically and empirically that the sorting process typically used in prior studies drives risk-taking findings. When we correct for this issue using a new methodology, we find that first half underperforming managers increase the risk of their portfolios in the second half of the year. We also find that this second half “tournament behavior” is unrelated to equity market returns in the first half of the year.

Mutual Funds, Tournaments, Bias

Abstract:
Previous results find CEOs' pay packages typically have low sensitivities to performance. Therefore, CEOs have incentives to increase firm size, even if those actions cause losses for current shareholders. Using nine versions of the Lipper/TASS Data, we investigate if hedge fund mangers' higher pay-performance sensitivities cause them to act in their current investors' best interests by limiting assets. While our results show closed hedge funds do experience significantly lower flows, managers' and management companies' primary objective is to hoard assets. These results suggest even high pay-performance deltas are not strong enough to overcome additional fees generated from larger amounts of assets. Other monitoring mechanisms are necessary to reduce agency costs for investors.

Hedge funds, closed to investment, compensation

Abstract:
Using a complete set of U.S. SEC filing information on hedge funds (Form ADV) and data from the Lipper TASS Hedge Fund Database, the study reported here developed a quantitative model called the É-score to measure hedge fund operational risk. The É-score is related to conflict-of-interest issues, concentrated ownership, and reduced leverage in the Form ADV data. With a statistical methodology, the study further related the É-score to such readily available information as fund performance, volatility, size, age, and fee structures. Finally, the study demonstrated that although operational risk is more significant than financial risk in explaining fund failure, a significant and positive interaction exists between operational risk and financial risk.

Risk Measurement and Management: Alternative Investments; Portfolio Management: Hedge Fund strategies; Alternative Investments: Hedge Fund Strategies